- Please model cash flows for American Greetings for fiscal years 2012 through 2015. Using a marginal tax rate of 40% and a market risk premium of 5%. What is your estimate of the appropriate discount rate for the free cash flow forecast? Based on a discounted cash flow model, what is your best estimate of the implied enterprise value of American Greetings and the corresponding share price? Discuss your results and the implications for the decision facing American Greetings.
CASE 45 American Greetings This year American Greetings is demonstrating to naysayers that the greeting card space is not dead. The company has accelerated top-line [growth] through a combination of organic growth and acquisitions, and year-to-date revenues are trending well ahead of our forecast. However, the growth has come at a cost that is also far greater than we had anticipated... In Q3 marketing, spending increased by a surprising $10 million... The company also accelerated investment spending in the digital space to support the growth of recently launched cardstore.com. In addition, [American Greetings] has incurred ... incremental expenses this year to roll out new doors in the dollar-store channel. -Jeff Stein, Managing Director, Northcoast Research EXHIBIT 45.1 | American Greetings Share Price (monthly close) It was New Year's Day 2012, and the weather was unseasonably warm in Cleveland, Ohio, headquarters for American Greetings Corporation (AG). But while temperatures were up, the same could not be said of AG's share price, which had been cut in half over the previous several months to a year-end closing price of $12.51 (Exhibit 45.1). $30 $25 $20 $15 $10 $5 $0 82292 889 Data source: Yahoo! Finance. El FE $5 Page 371 FF At times of low equity valuation, AG management historically had turned to share buybacks. With current valuation levels, management was considering going into the market with a $75 million repurchase program. The repurchase was to be funded from AG's operating profit and cash reserves. The decision hinged on how the future of the enterprise was expected to play out. If the share price reasonably reflected bleak prospects for AG, management should preserve cash for future needs. If, on the other hand, AG stock was simply temporarily out of favor, the buyback plan presented a prudent defensive strategy. American Greetings With $1.7 billion in revenue, AG was the second-largest greeting card publisher in the United States. To meet the changing times, AG sold greeting cards as both paper products through traditional retail channels and electronic products through a number of company websites. In addition to gift cards, AG marketed gift wrap, candles, party goods, candles, and other giftware. To strengthen its business, the company owned and maintained the Page 572 following major brands: American Greetings, Carlton Cards, Gibson, Recycled Paper Greetings, Papyrus, and DesignWare. AG owned the rights to a variety of popular characters, including Strawberry Shortcake, the Care Bears, Holly Hobbie, the Get Along Gang, and the Nickelodeon characters. The company was able to generate additional revenue by licensing the rights to these characters. Overall, management positioned AG as a leader in social expression products that assisted "consumers in enhancing their relationships to create happiness, laughter, and love."1 The company had a long affiliation with the founding Sapirstein family. Shortly after immigrating to the United States in 1905, Jacob Sapirstein, a Polish entrepreneur, launched a business distributing German manufactured postcards in Cleveland with the help of his young family. Eventually the business leadership was passed on to Jacob's oldest son, Irving Stone, then to Irving's son-in-law, Morry Weiss. In 2003, Morry's sons, Zev and Jeffrey Weiss, were appointed as CEO and president, respectively. Morry Weiss continued to serve as chairman. Despite the strong family affiliation, AG was widely held in the public equity markets, with more than 11,000 shareholders, including large positions by such institutional investors as the British investment fund MAM Investments (10.6% of AG shares) and U.S. funds Dimensional Fund Advisors (10.5%), BlackRock (7.9%), and LSV Asset Management (6.7%). Dividend payments to investors had been on an upward trend in recent years, rising from 12 cents per share in 2004 to 56 cents in 2010. Exhibits 45.2 and 45.3 provide AG's detailed financial statements. Since AG's fiscal year ended in February, the figures for 2011, for example, included results through February 2012, so remained estimates for the remaining two months. EXHIBIT 45.2 | American Greetings Income Statement, December 2011 (in millions of dollars) Total American Grootings Figures Total Revenue Material, Labor, and Other Pruduction Costs Selling, Distribution, and Marketing Expenses Administrative and General Expenses Goodwill and Other Intangible Asset Impairments Other Operating Expenses Operating Income Net Interest and Other Nonoperating Expenses Income Before Income Tax Expense Income Tax Expense Net Income Earnings Per Share (Basic) Dividends per Share By Business Unit Operating Segment Net Sales North American Social Expression Products International Social Expression Products Retail Operations AG Interactive Operating Segment Earnings North American Social Expression Products International Social Expression Products Retail Operations AG Interactive Total Revenue by Product Category Everyday Greeting Cards Seasonal Greeting Cards Gift Packaging Other Revenue All Other Products Cash and Cash Equivalents Trade Accounts Receivable Inventories Prepaid Expenses Other Current Assets Total Current Assets Net Property, Plant, and Equipment and Other Assets Total Assets Debt Due within One Year Accounts Payable Other Current Liabilities Current Liabilities 2008 (Feb 2009) Long-Term Debt Other Liabilities 1,691 Shareholders' Equity Total Liabilities and Shareholders' Equity 810 619 226 290 1 (253) 22 (275) (47) (228) (4.89) 0.60 1,095 271 179 83 70 (78) (19) (162) 704 357 Data sources: Company accounts; management and case writer estimates. Fiscal year ends February of subsequent year. 240 44 345 2009 (Feb 2010) 138 136 164 148 94 679 850 1,529 ********* **** ***** 1 95 272 369 2010 (Feb 2011) 329 196 636 1,529 1,593 682 **** 216 120 180 128 72 716 Data sources: Company accounts; management and case writer estimates. Fiscal year ends February of subsequent year. 832 1,547 478 2.18 0.56 261 1,191 262 0 87 245 332 175 233 219 763 1,547 19 EXHIBIT 45.3 | American Greetings Balance Sheet (in millions of dollars) 2009 (Feb 2010) 156 69 87 2010 (Feb 2011) 78 218 20 14 753 377 223 32 207 2011E (Feb 2012) 1,677 743 526 258 0 (6) 157 28 129 47 82 2.22 0.60 1,215 344 68 148 20 14 823 408 239 32 176 2011E (Feb 2012) 172 130 190 131 54 677 859 1,536 0 87 255 343 235 206 752 1,536 cards electronically. Card manufacturers maintained websites that allowed consumers to purchase paper greeting cards on the Internet via computer or smart phone and have the physical cards delivered directly to the recipient. Kiosks had been placed in retail stores that allowed customers to create custom cards. Distribution had expanded to build a substantive presence in the expanding dollar-store retail channel, where greeting cards were reported to be a top-selling item. Despite the trends, large numbers of people continued to buy greeting cards. In a recent survey, 52% of U.S. respondents had purchased a greeting card in the past three months. This figure was down from 59% who had responded affirmatively in 2006. Valuation With an end-of-year close of $12.51 per share, AG's PE ratio was at 6 times, its enterprise value to EBITDA ratio at 3.5 times, and its market-to-book ratio was below 1. All these valuation ratios were at the bottom of AG's group of comparable companies. Exhibit 45.6 contains financial details and business descriptions for the AG-comparable group. AG's management believed its valuation suggested an opportunity, but low levels also demonstrated substantial concern by the capital market regarding the prospects of the company. For example, equity analysts at Standard and Poor's maintained a hold recommendation on the stock, claiming the following: We see [AG's 2012] sales increasing 2.5% to $1.73 billion. . . . We see demand benefitting from increased promotional spending in a more stable economic environment as the company pursues growth within the discount distribution channel . . . acquisitions . . . [and] international sales . . . We expect margins to narrow ... reflecting a shift in customer mix toward the discount channel, increasing marketing costs to spur demand, distribution expansion costs, and expenses related to plans to move AG's headquarters building. While we believe channel migration will result in a permanent negative margin shift, we do not believe transition costs related to expanded distribution efforts will be a factor in the long term. EXHIBIT 45.6 | Comparable Firms, End of 2011 (in millions of dollars except share price) American Greetings Blyth Consolidated Graphics CSS Industries Deluxe Hallmark Lancaster Colony Meredith Scholastic American Greetings Blyth Consolidated Graphics CSS Industries Deluxe Hallmark Lancaster Colony Meredith Scholastic Blyth Consolidated Graphics CSS Industries Deluxe Lancaster Colony Meredith Share Shares Price Outstanding Cash Scholastic 12.51 56.80 48.28 19.92 22.76 69.34 32.65 29.97 ROA 7% 4% 5% 4% 13% NA 14% 7% 6% 38.3 8.2 10.2 9.7 50.9 27.3 44.8 31.1 ROE 11% 9% 10% 2% 55% 19% 15% 8% Total 86 182 7 Data source: Case writer descriptions. .. 10 24 31 162 26 114 35 Total Enterprise Value Debt 0.42 1.75 235 101 197 0 742 Data sources: Yahool Finance, Standard & Poor's, Mergent. *EBITDA miltiple is defined as Enterprise Value divided by EBITDA **The ratings for Cons. Graphics and Meredith are estimated by case writer. NA 250 215 Bond Bota Rating" 1.63 BB+ 1.60 B 1.45 BB 1.36 1.85 B BB 1.04 BB- 714 568 692 194 1,901 1,890 1,712 1,145 EBITDA Revenue EBITDA Multiple 1,660 984 1,050 453 1,420 4,100 1,090 1,350 1,950 204 48 3.5 11.7 5.6 30 6.5 359 5.3 NA 156 12.2 240 189 122 7.1 6.0 Global marketer of candles, gourmet foods, weight management products, holiday cards, photo albums, and houseware products Provides commercial printing services in North America, including brochures, share holder communications, trading cards, calendars, catalogs, and greeting cards Designs, produces, and sells social expression products in North America, including greeting cards, gift wrapping, Valentine cards, Halloween costumes, and stationery Provides printed products to financial institutions and small businesses worldwide, including forms, checks, envelopes, and greeting cards Manufactures and markets specialty foods, glassware, and candles in the United States Licenses brands and publishes magazines (e.g., Better Homes and Gardens, Ladies' Home Journal, FamilyFun) in the United States Publishes and distributes children's books and other media in the United States Orly Seidman, a Value Line analyst, held a more optimistic view, expecting steady margins and steady long- term growth: The company has been improving the product pipeline. Management should continue to follow consumer and societal trends to better brand its offerings. It has shifted its focus from its core segment to pursue noncard merchandise. Product innovation, stronger retail partnerships, and sell-diversified portfolio ought to drive customer interest in its goods. Technological enhancements will likely remain key to its long-term approach. Over the past few quarters, [AG] rolled out several complementary interactive products (i.e., mobile apps) and should continue to bolster its digital position. Page 574 It was clear that there was substantial disagreement regarding the future growth trajectory and operating margins for the company. Over the past several years, revenue growth had been near to below zero. In 2011, however, revenue growth was anticipated to be more than 7% (Exhibit 45.7). Similarly, operating margins, which had been abnormally low two to five years previously, had improved to 9% recently. The marginal tax rate for AG income was 39%. EXHIBIT 45.7 American Greetings Operating Performance 2005 2006 2007 2008 2009 -7% 2% -1% 5% -5% -1% -3% 6% Revenue Growth Operating Margin 10% 8% 6%- 4% 2% 0% -2% - -4%- -6% -8% 2005 0% 8% Note: Fiscal year ends February of subsequent year. Data source: Company financial statements. 2006 2007 2008 2009 2010 -Revenue growth Operating margin Bullish Scenario Revenue Growth Operating Margin EXHIBIT 45.8 Financial Forecast Assumptions Bearish Scenario Revenue Growth Operating Margin A bullish view held that AG would be able to maintain operating margins at 9% and achieve long-term ongoing revenue growth of 3%. A bearish view held that AG's prospective revenue growth would be near zero into the future and that margins would continue to erode to a long-term rate of 5%. The expectation was that recent investments and ongoing electronic product substitution would generate some future working capital efficiency for AG, but there was little evidence that fixed asset turnover would improve. Exhibit 45.8 details the specific assumptions for the two scenarios. Not Working Capital Turnover Fixed Asset Turnover Not Working Capital Turnover Fixed Asset Turnover Actual 2011 5.3% 9.4% 5.02 1.95 5.3% 9.4% 5.02 1.95 2012 1.0% 9.0% 6.00 1.95 0.0% 8.0% 6.00 1.95 Forecast 2013 EXHIBIT 45.9 Capital Market Data 1.5% 9.0% 6.50 1.95 2010 -2% 9% 0.0% 7.0% 6.50 1.95 2011 2014 2.0% 9.0% 7.00 1.95 0.0% 6.0% 2011 7% 9% 7.00 1.95 2015 2.5% 9.0% 7.50 1.95 0.0% 5.0% 7.50 1.95 Note: The ratios are defined in the following manner: Revenue Growth is the annual percentage change in total revenue, Operating Margin is operating income divided by total revenue, Net Working Capital Turnover is total revenue divided by net working capital where net working capital is current assets less current liabilities, Fixed Asset Turnover is total revenue divided by net PP&E and other assets. Data source: Case writer estimates. Management understood that returns and growth were challenging to achieve in early 2012. Yields on U.S. Treasury bills bonds were at historic lows of 0.1% and 2.8%, respectively (Exhibit 45.9). In such an environment, investors would richly reward returns of even small magnitudes. 30-Day Treasury Bill 10-Year Treasury Bond 10-Year Corporate Bonds of Industrial Companies AAA AA A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- Historical Market Risk Premium Equity Market Index Less Government Debt Yield 0.1% 2.8% 2.8% 2.9% 3.2% 3.3% 3.5% 3.8% 4.1% 4.6% 5.8% 6.5% 6.5% 6.8% 8.4% 9.0% 5.5% 5-Year Forecast U.S. Real GDP Annual Growth Rate 3.3% U.S. GDP Annual Deflator Rate 1.8% Consumer Price Index Annual Rate 2.2% Data sources: Bloomberg, Value Line Investment Survey, and case writer estimates. CASE 45 American Greetings This year American Greetings is demonstrating to naysayers that the greeting card space is not dead. The company has accelerated top-line [growth] through a combination of organic growth and acquisitions, and year-to-date revenues are trending well ahead of our forecast. However, the growth has come at a cost that is also far greater than we had anticipated... In Q3 marketing, spending increased by a surprising $10 million... The company also accelerated investment spending in the digital space to support the growth of recently launched cardstore.com. In addition, [American Greetings] has incurred ... incremental expenses this year to roll out new doors in the dollar-store channel. -Jeff Stein, Managing Director, Northcoast Research EXHIBIT 45.1 | American Greetings Share Price (monthly close) It was New Year's Day 2012, and the weather was unseasonably warm in Cleveland, Ohio, headquarters for American Greetings Corporation (AG). But while temperatures were up, the same could not be said of AG's share price, which had been cut in half over the previous several months to a year-end closing price of $12.51 (Exhibit 45.1). $30 $25 $20 $15 $10 $5 $0 82292 889 Data source: Yahoo! Finance. El FE $5 Page 371 FF At times of low equity valuation, AG management historically had turned to share buybacks. With current valuation levels, management was considering going into the market with a $75 million repurchase program. The repurchase was to be funded from AG's operating profit and cash reserves. The decision hinged on how the future of the enterprise was expected to play out. If the share price reasonably reflected bleak prospects for AG, management should preserve cash for future needs. If, on the other hand, AG stock was simply temporarily out of favor, the buyback plan presented a prudent defensive strategy. American Greetings With $1.7 billion in revenue, AG was the second-largest greeting card publisher in the United States. To meet the changing times, AG sold greeting cards as both paper products through traditional retail channels and electronic products through a number of company websites. In addition to gift cards, AG marketed gift wrap, candles, party goods, candles, and other giftware. To strengthen its business, the company owned and maintained the Page 572 following major brands: American Greetings, Carlton Cards, Gibson, Recycled Paper Greetings, Papyrus, and DesignWare. AG owned the rights to a variety of popular characters, including Strawberry Shortcake, the Care Bears, Holly Hobbie, the Get Along Gang, and the Nickelodeon characters. The company was able to generate additional revenue by licensing the rights to these characters. Overall, management positioned AG as a leader in social expression products that assisted "consumers in enhancing their relationships to create happiness, laughter, and love."1 The company had a long affiliation with the founding Sapirstein family. Shortly after immigrating to the United States in 1905, Jacob Sapirstein, a Polish entrepreneur, launched a business distributing German manufactured postcards in Cleveland with the help of his young family. Eventually the business leadership was passed on to Jacob's oldest son, Irving Stone, then to Irving's son-in-law, Morry Weiss. In 2003, Morry's sons, Zev and Jeffrey Weiss, were appointed as CEO and president, respectively. Morry Weiss continued to serve as chairman. Despite the strong family affiliation, AG was widely held in the public equity markets, with more than 11,000 shareholders, including large positions by such institutional investors as the British investment fund MAM Investments (10.6% of AG shares) and U.S. funds Dimensional Fund Advisors (10.5%), BlackRock (7.9%), and LSV Asset Management (6.7%). Dividend payments to investors had been on an upward trend in recent years, rising from 12 cents per share in 2004 to 56 cents in 2010. Exhibits 45.2 and 45.3 provide AG's detailed financial statements. Since AG's fiscal year ended in February, the figures for 2011, for example, included results through February 2012, so remained estimates for the remaining two months. EXHIBIT 45.2 | American Greetings Income Statement, December 2011 (in millions of dollars) Total American Grootings Figures Total Revenue Material, Labor, and Other Pruduction Costs Selling, Distribution, and Marketing Expenses Administrative and General Expenses Goodwill and Other Intangible Asset Impairments Other Operating Expenses Operating Income Net Interest and Other Nonoperating Expenses Income Before Income Tax Expense Income Tax Expense Net Income Earnings Per Share (Basic) Dividends per Share By Business Unit Operating Segment Net Sales North American Social Expression Products International Social Expression Products Retail Operations AG Interactive Operating Segment Earnings North American Social Expression Products International Social Expression Products Retail Operations AG Interactive Total Revenue by Product Category Everyday Greeting Cards Seasonal Greeting Cards Gift Packaging Other Revenue All Other Products Cash and Cash Equivalents Trade Accounts Receivable Inventories Prepaid Expenses Other Current Assets Total Current Assets Net Property, Plant, and Equipment and Other Assets Total Assets Debt Due within One Year Accounts Payable Other Current Liabilities Current Liabilities 2008 (Feb 2009) Long-Term Debt Other Liabilities 1,691 Shareholders' Equity Total Liabilities and Shareholders' Equity 810 619 226 290 1 (253) 22 (275) (47) (228) (4.89) 0.60 1,095 271 179 83 70 (78) (19) (162) 704 357 Data sources: Company accounts; management and case writer estimates. Fiscal year ends February of subsequent year. 240 44 345 2009 (Feb 2010) 138 136 164 148 94 679 850 1,529 ********* **** ***** 1 95 272 369 2010 (Feb 2011) 329 196 636 1,529 1,593 682 **** 216 120 180 128 72 716 Data sources: Company accounts; management and case writer estimates. Fiscal year ends February of subsequent year. 832 1,547 478 2.18 0.56 261 1,191 262 0 87 245 332 175 233 219 763 1,547 19 EXHIBIT 45.3 | American Greetings Balance Sheet (in millions of dollars) 2009 (Feb 2010) 156 69 87 2010 (Feb 2011) 78 218 20 14 753 377 223 32 207 2011E (Feb 2012) 1,677 743 526 258 0 (6) 157 28 129 47 82 2.22 0.60 1,215 344 68 148 20 14 823 408 239 32 176 2011E (Feb 2012) 172 130 190 131 54 677 859 1,536 0 87 255 343 235 206 752 1,536 cards electronically. Card manufacturers maintained websites that allowed consumers to purchase paper greeting cards on the Internet via computer or smart phone and have the physical cards delivered directly to the recipient. Kiosks had been placed in retail stores that allowed customers to create custom cards. Distribution had expanded to build a substantive presence in the expanding dollar-store retail channel, where greeting cards were reported to be a top-selling item. Despite the trends, large numbers of people continued to buy greeting cards. In a recent survey, 52% of U.S. respondents had purchased a greeting card in the past three months. This figure was down from 59% who had responded affirmatively in 2006. Valuation With an end-of-year close of $12.51 per share, AG's PE ratio was at 6 times, its enterprise value to EBITDA ratio at 3.5 times, and its market-to-book ratio was below 1. All these valuation ratios were at the bottom of AG's group of comparable companies. Exhibit 45.6 contains financial details and business descriptions for the AG-comparable group. AG's management believed its valuation suggested an opportunity, but low levels also demonstrated substantial concern by the capital market regarding the prospects of the company. For example, equity analysts at Standard and Poor's maintained a hold recommendation on the stock, claiming the following: We see [AG's 2012] sales increasing 2.5% to $1.73 billion. . . . We see demand benefitting from increased promotional spending in a more stable economic environment as the company pursues growth within the discount distribution channel . . . acquisitions . . . [and] international sales . . . We expect margins to narrow ... reflecting a shift in customer mix toward the discount channel, increasing marketing costs to spur demand, distribution expansion costs, and expenses related to plans to move AG's headquarters building. While we believe channel migration will result in a permanent negative margin shift, we do not believe transition costs related to expanded distribution efforts will be a factor in the long term. EXHIBIT 45.6 | Comparable Firms, End of 2011 (in millions of dollars except share price) American Greetings Blyth Consolidated Graphics CSS Industries Deluxe Hallmark Lancaster Colony Meredith Scholastic American Greetings Blyth Consolidated Graphics CSS Industries Deluxe Hallmark Lancaster Colony Meredith Scholastic Blyth Consolidated Graphics CSS Industries Deluxe Lancaster Colony Meredith Share Shares Price Outstanding Cash Scholastic 12.51 56.80 48.28 19.92 22.76 69.34 32.65 29.97 ROA 7% 4% 5% 4% 13% NA 14% 7% 6% 38.3 8.2 10.2 9.7 50.9 27.3 44.8 31.1 ROE 11% 9% 10% 2% 55% 19% 15% 8% Total 86 182 7 Data source: Case writer descriptions. .. 10 24 31 162 26 114 35 Total Enterprise Value Debt 0.42 1.75 235 101 197 0 742 Data sources: Yahool Finance, Standard & Poor's, Mergent. *EBITDA miltiple is defined as Enterprise Value divided by EBITDA **The ratings for Cons. Graphics and Meredith are estimated by case writer. NA 250 215 Bond Bota Rating" 1.63 BB+ 1.60 B 1.45 BB 1.36 1.85 B BB 1.04 BB- 714 568 692 194 1,901 1,890 1,712 1,145 EBITDA Revenue EBITDA Multiple 1,660 984 1,050 453 1,420 4,100 1,090 1,350 1,950 204 48 3.5 11.7 5.6 30 6.5 359 5.3 NA 156 12.2 240 189 122 7.1 6.0 Global marketer of candles, gourmet foods, weight management products, holiday cards, photo albums, and houseware products Provides commercial printing services in North America, including brochures, share holder communications, trading cards, calendars, catalogs, and greeting cards Designs, produces, and sells social expression products in North America, including greeting cards, gift wrapping, Valentine cards, Halloween costumes, and stationery Provides printed products to financial institutions and small businesses worldwide, including forms, checks, envelopes, and greeting cards Manufactures and markets specialty foods, glassware, and candles in the United States Licenses brands and publishes magazines (e.g., Better Homes and Gardens, Ladies' Home Journal, FamilyFun) in the United States Publishes and distributes children's books and other media in the United States Orly Seidman, a Value Line analyst, held a more optimistic view, expecting steady margins and steady long- term growth: The company has been improving the product pipeline. Management should continue to follow consumer and societal trends to better brand its offerings. It has shifted its focus from its core segment to pursue noncard merchandise. Product innovation, stronger retail partnerships, and sell-diversified portfolio ought to drive customer interest in its goods. Technological enhancements will likely remain key to its long-term approach. Over the past few quarters, [AG] rolled out several complementary interactive products (i.e., mobile apps) and should continue to bolster its digital position. Page 574 It was clear that there was substantial disagreement regarding the future growth trajectory and operating margins for the company. Over the past several years, revenue growth had been near to below zero. In 2011, however, revenue growth was anticipated to be more than 7% (Exhibit 45.7). Similarly, operating margins, which had been abnormally low two to five years previously, had improved to 9% recently. The marginal tax rate for AG income was 39%. EXHIBIT 45.7 American Greetings Operating Performance 2005 2006 2007 2008 2009 -7% 2% -1% 5% -5% -1% -3% 6% Revenue Growth Operating Margin 10% 8% 6%- 4% 2% 0% -2% - -4%- -6% -8% 2005 0% 8% Note: Fiscal year ends February of subsequent year. Data source: Company financial statements. 2006 2007 2008 2009 2010 -Revenue growth Operating margin Bullish Scenario Revenue Growth Operating Margin EXHIBIT 45.8 Financial Forecast Assumptions Bearish Scenario Revenue Growth Operating Margin A bullish view held that AG would be able to maintain operating margins at 9% and achieve long-term ongoing revenue growth of 3%. A bearish view held that AG's prospective revenue growth would be near zero into the future and that margins would continue to erode to a long-term rate of 5%. The expectation was that recent investments and ongoing electronic product substitution would generate some future working capital efficiency for AG, but there was little evidence that fixed asset turnover would improve. Exhibit 45.8 details the specific assumptions for the two scenarios. Not Working Capital Turnover Fixed Asset Turnover Not Working Capital Turnover Fixed Asset Turnover Actual 2011 5.3% 9.4% 5.02 1.95 5.3% 9.4% 5.02 1.95 2012 1.0% 9.0% 6.00 1.95 0.0% 8.0% 6.00 1.95 Forecast 2013 EXHIBIT 45.9 Capital Market Data 1.5% 9.0% 6.50 1.95 2010 -2% 9% 0.0% 7.0% 6.50 1.95 2011 2014 2.0% 9.0% 7.00 1.95 0.0% 6.0% 2011 7% 9% 7.00 1.95 2015 2.5% 9.0% 7.50 1.95 0.0% 5.0% 7.50 1.95 Note: The ratios are defined in the following manner: Revenue Growth is the annual percentage change in total revenue, Operating Margin is operating income divided by total revenue, Net Working Capital Turnover is total revenue divided by net working capital where net working capital is current assets less current liabilities, Fixed Asset Turnover is total revenue divided by net PP&E and other assets. Data source: Case writer estimates. Management understood that returns and growth were challenging to achieve in early 2012. Yields on U.S. Treasury bills bonds were at historic lows of 0.1% and 2.8%, respectively (Exhibit 45.9). In such an environment, investors would richly reward returns of even small magnitudes. 30-Day Treasury Bill 10-Year Treasury Bond 10-Year Corporate Bonds of Industrial Companies AAA AA A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- Historical Market Risk Premium Equity Market Index Less Government Debt Yield 0.1% 2.8% 2.8% 2.9% 3.2% 3.3% 3.5% 3.8% 4.1% 4.6% 5.8% 6.5% 6.5% 6.8% 8.4% 9.0% 5.5% 5-Year Forecast U.S. Real GDP Annual Growth Rate 3.3% U.S. GDP Annual Deflator Rate 1.8% Consumer Price Index Annual Rate 2.2% Data sources: Bloomberg, Value Line Investment Survey, and case writer estimates
